Can Cisco ever again recapture the dazzle of its brilliant youth?

MANAGEMENT shake-ups are a tricky business. They are most necessary when sales are plunging, but at such times they can easily make things worse. That was the dilemma faced by Cisco, the battered networking giant, when it announced, on August 23rd, its most important management shake-up in four years, aimed mainly at centralising its engineering and marketing.

The timing of the reorganisation might be right because the trough appears to be near. After a dramatic drop in recent months, Cisco's business is stabilising, according to John Chambers, its chief executive. But the Silicon Valley company still has a long way to go if it is to achieve its self-imposed growth target of 30-50% a year once the networking industry recovers from its slump. Can it ever recapture the dazzle and status that it had as the wunderkind of the “new economy”?

For wunderkind it certainly was. It built most of the engines (80%, according to some estimates) for the Internet revolution: souped-up computers called routers that guide data through networks. But the firm was admired not only for what it did, but for how it did it. Cisco was almost boringly perfect. It mastered the art of serial acquisitions and outsourced all the dirty work to contract manufacturers.

Small wonder that its share price seemed to know no limits. On March 27th 2000, the firm's market capitalisation reached $548 billion, making it briefly the most valuable company in the world (see chart). That increased the shock when the company hit the wall. On April 16th this year, it announced that sales in its next quarter would fall by almost one-third, and that it would lay off 8,500 employees, 17% of its workforce. Cisco, Mr Chambers said, had been hit by a once-a-century flood: “We never built models to anticipate anything of this magnitude.”

Cisco's big competitors, such as Nortel and Lucent, are admittedly in much worse shape. Yet some of Cisco's woes appear to be home-made. Having become addicted to growth rates of 60% and more, its management apparently had a hard time finding the brakes. “If you don't believe that it is going to rain, it takes a lot of rain to convince you,” says Paul Johnson, an analyst with Robertson Stephens, an investment bank, who is a long-time Cisco watcher.

To be sure, without its much-vaunted internal information systems, Cisco's wounds would be much deeper. Larry Carter, its chief financial officer, probably has access to more information on his PC than any of his rivals at other big companies. But his “cockpit” is no crystal ball. Cisco's management appears to have relied too much on its own numbers, ignoring external warning signs. In early December last year, Mr Chambers still saw an opportunity for his firm to “break away” from its competitors, even though many of its telecoms customers were already in serious financial trouble.

Nor was the famous supply chain as responsive as it might have been. Technology and outsourcing have made supply chains more efficient, but also longer, which means they cannot be switched off immediately. There is always a lot of material in the pipeline, some of it going from America to Asia and back again.

What made things worse in Cisco's case was that it had, in the summer of 2000, aggressively ordered components so as to cut down on its lead times, which had reached 15 weeks for some products. The firm thus found itself saddled with a huge inventory of parts, of which it had to write off a whopping $2.5 billion-worth.

Cisco did not in every case manage the trick of buying good technology and marketing it successfully

Analysts are also increasingly questioning Cisco's ability in one of its trademark fields: the serial acquisition of other start-ups. Has its takeover of 73 companies since 1993 really been the unmitigated success it is often claimed to be? The first acquisitions, such as Crescendo Communications, were certainly winners. But Cisco did not in every case manage the trick of buying good technology and getting its legendary sales force to market it successfully. The company has just cancelled a networking product developed by Monterey Networks, a start-up that it bought as recently as 1999 (for $501m), because the gear was “ahead of its time”.

In any event, Cisco will find it difficult to be as acquisitive as in the past, at least in the foreseeable future. So far this year, it has bought only two companies, Allegro Systems and AuroraNetics (after buying 23 in 2000). The crop is thin partly because venture capitalists are financing far fewer suitable start-ups, but also because Cisco is far less attractive as an acquirer. Its shares are no longer the top currency that they once were. Many leading engineers and entrepreneurs now see the company as a bureaucratic behemoth.

Tornados to tame

Acquisitions will remain an important part of Cisco's strategy, the company says, even if that means paying cash, of which it has plenty. But its restructuring programme suggests that it intends to make its own internal research and development effort more efficient—something that its critics have often advised.

Until now, the firm was divided into three units focusing on different types of customer: big companies, small businesses and telecoms carriers. This set-up had the disadvantage that the units often duplicated efforts on the same technology. Now there will be 11 groups, each in charge of one key area—such as wireless networks, optical equipment or storage.

Getting more bang for its R&D bucks is not the main rationale for the shake-up, says Mario Mazzola, Cisco's new chief development officer, who will oversee the new groups. The changes are more a reaction to customer demand, he says. When Cisco created its present structure in April 1997, different types of customer wanted to build different networks. Now their requirements are increasingly the same; all want to create seamless networks built on Internet technologies.

The new set-up, Cisco hopes, will make it possible to achieve its ambitious 30-50% growth targets. The structure is supposed to allow the firm to focus better on the areas that it has identified as “tornado” markets—which it expects to grow just as rapidly as its traditional router business. The company has identified six such markets, including systems to deliver digital content intelligently over the network, wireless gear for home and offices, and fibre-optic equipment, in particular for networks in metropolitan areas.

Analysts remain sceptical. It is hard to grow that quickly if you are as big as Cisco, which generated revenues of $22.3 billion in its latest fiscal year. What is more, the growth target also presumes that the firm will dominate these tornado markets, and that its core business will continue to expand rapidly, neither of which can be taken for granted. Between 15% and 20% would, analysts suggest, be a more realistic growth target. But Cisco's management insists on the higher figures (although Mr Chambers recently qualified them as a “stretch goal”). Make no mistake, though, even a slower-growing Cisco will remain a formidable company.